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All investing is subject to risk, including the possible loss of the money you invest.

Several years ago at a speech in New York, I warned that “a future President Clinton or McCain would face a daunting budget challenge from population aging.” My political forecast was off, but my economic and demographic forecast is unchanged.

It is a well-known demographic fact that societies around the world are aging. It is not just a U.S. phenomenon (the impact is somewhat muted here by immigration) or a developed-world phenomenon. Even countries like Mexico and China are facing rapidly graying populations. Some demographers have suggested that the global population will reach an historic first in the current century: The proportion who are elderly is expected to exceed the proportion who are young.

Global aging has a fiscal impact, and there is no better demonstration of that than in the current U.S. budget outlook (see table below). Over the next 10 years, the federal government’s revenue is expected to grow by an additional $2 trillion. That growth in revenue will be entirely offset by additional Social Security and Medicare expenses (an increase of a half-trillion dollars each), growth in Medicaid (a material portion of which will pay for long-term nursing-home costs for older Americans), and interest on the debt.

As a percent of the aggregate economy, the deficit will fall from 10.6% to 4.2% over the period. Yet the economic policy goal should be to balance huge deficit spending today—necessary to counteract the financial crisis and “Depression 2.0″—with budget surpluses in the future. This is impossible given the inexorable rise of spending on old-age programs. As you can see from the numbers, if there were no material growth in aging programs over the coming decade, the collective budget would be in surplus by 2020 (lower benefits growth would also reduce interest costs).

In the current budget debate, the deficit issue has been conflated with the financial crisis. If the financial crisis had occurred 20 or 30 years ago, it would likely have meant a onetime surge in deficits and debt, and a relatively minor aberration in the long-term growth path of the U.S. But the banking crisis came at precisely the worst time—just on the threshold of a large wave in government spending on old-age programs. Hence the stream of red ink.

The good news, I suppose, is that the U.S. is better off than other countries. In Europe, public pensions are higher and immigration rates lower. Birth rates in both regions for non-immigrants are roughly the same: at replacement rates; the main difference is that in the U.S., (mostly Hispanic) immigrants are having more children, easing the aging burden. (That is a quite different perspective on the merits of immigration: Young immigrants pay Social Security and Medicare taxes!) Intertwined with this, of course, is the secular increase in health care costs, in the U.S. and around the world.

The Obama administration has created a new commission to tackle the long-term budget issue. The options have been known for several decades and are clear: higher taxes, which of course weigh heavily on working-age families and hinder economic growth, or reduced benefits, which means a transfer of resources away from older Americans and an increase in economic insecurity in old age.

In the end, the debate will be over how many public resources should be devoted to the old-age population—a debate over how gray the budget should be as the population ages.

Note: The link to the White House website will open a new browser window. Vanguard accepts no responsibility for content on third-party websites.

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Steve Utkus

Steve Utkus oversees the Vanguard Center for Retirement Research, which studies many aspects of retirement in America—from how individuals start saving and investing in the early part of their careers, to how they prepare for actual retirement, to how they spend down their savings once they’re retired. Steve is particularly interested in behavioral finance—the study of how rational decision-making is influenced by human psychology. His current research interests also include the ways employers design retirement programs, and new developments in retirement in other countries. Steve holds a B.S. from the Massachusetts Institute of Technology and an M.B.A. from the University of Pennsylvania's Wharton School. He began working at Vanguard in 1987 and has served as director of the Center for Retirement Research since 2001. Steve is also a visiting scholar at the Wharton School.

Comments

Richard G. | September 22, 2015 12:10 pm

As owners of Vanguard by and large we would be considered savers and investors. Folkes we have seen the hand wriying on the wall for several generations now. The government is not suppose to bail you out. Vanguards mantra since it’s inception is save invest and get debt free asap. They make it easier to invest and grow our portifolios by offering the American public rock bottom costs.After a 44 year work history I can blame no one but myself if I was not financially comfortable as most Vanguardians are.The person who is responsible for your financial survival is you looking in the mirror.By retirement time everyone should have their respective programs hitting om all 8 cylinders and most of the hay should be in your barn.Vanguard has helped me make money and I expect more of the same when I begin RMD’s. Good Luck to All.

Anonymous | May 11, 2010 2:46 pm

You are right. The demographics tell us we have a very serious problem. But your link to the White House version of the Federal budget deficit is sadly lacking to illustrate your point. Your suggested link for the Federal budget deficit presents an overly-rosy scenario; the annual Federal budget deficit is subject to manipulation and omissions and tells only a tiny piece of the total gross debt problem. Many items are missing, for example the funds expended for Fannie Mae (today I think I read the number is up to $145 billion). Missing are the looming entitlements.
For anyone who is interested, the 2005 The Coming Generational Storm, 2005, by Laurence J. Kotlikoff gives a good picture of the demographics and how this looming debt burden will affect our economy. Since 2005, the picture only looks worse.
Neither party is addressing the gross national debt or the additional entitlements.
Thank you.

Anonymous | April 20, 2010 7:11 am

Anonymous | April 20, 2010 7:02 am

1. More babies are not the solution. There are too many of us now.
2. The table suggests growth in the U.S. economy. No one can guarantee growth.
3. The “Greatest Generation” has left a Greatest Debt. We should plan to pay over
a stated period. What should that be? 100 years? 50 years? 25 years?
4. No one trusts Washington to be fiscally responsible. We should publish a plan
for discharging our debt and tax ourselves to do so. We should index all loans,
debts, transactions to inflation. Washington is not going to do this; states can.
5. We should simplify the tax code to one page only. Someone threw the
moneychangers out of the temple. We can do the same, state by state.
6. Every industry can have 10 competitors by law. Some economy of scale will
be lost, and we will never have companies that are too big to fail. Start with
reform state by state.
7. States and large cities can medically self-insure via optional non-profit
companies for those citizens seeking such care. Medical records can use
simple formats such as WordPerfect or Word, with optional encryption
controlled by patients for privacy of genetic information etc.

Anonymous | March 14, 2010 10:39 am

I would like to see taxes greatly increased now, while many of us boomers are still working. After all, we’re currently paying historically low tax rates. Many businesses eliminated pensions and 401Ks were promoted as a substitute. What will happen to the value of these investments when we boomers stop contributing to our 401Ks (stop purchasing stock)? Also,
I would like for the U.S. to adopt a single-payer health care system. Businesses in the U.S. will eventually not be able to afford insurance subsides for employees if they are to remain competitive globally.

Anonymous | March 10, 2010 5:38 pm

It seems that the more we expect from government the less we will get. There is a founding father statement that says “a government that is big enough to give you everything is a goverment big enough to take everything you have. I worked for a company that provided a pension. That pension would have provided more income then the social security that I receive. The private sector has the potential to provide more finacial security than government at a far lower cost. When have we ever had the government do something that didn’t cost far more than was projected? Government is vital for the national security of a country and that should be about the only thing they are to do.

Anonymous | March 5, 2010 11:37 pm

Anonymous | February 25, 2010 2:11 am

The party will soon be over. Social security always was a type of pyramid scheme. Means testing will someday become necessary. Those with the means to support themselves will not get social security. Those who can’t support themselves will get some kind of “minimum existence” payment.

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.